REAL EXCHANGE RATE MISALIGNMENT IN MONETARY POLICY CONSTRAINED ECONOMIES: EVIDENCE FROM ESWATINI, LESOTHO, AND NAMIBIA

Mukela Mabakeng (), Merrinah Siboli and Saara Mukumangeni-Kashaka
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Mukela Mabakeng: Bank of Namibia (Central Bank of Namibia)
Merrinah Siboli: Bank of Namibia (Central Bank of Namibia)
Saara Mukumangeni-Kashaka: Bank of Namibia (Central Bank of Namibia)

Review of Economic and Business Studies, 2024, issue 33, 103-126

Abstract: This paper examined the misalignment of the real effective exchange rate among the smaller, open and monetary policy constrained members of the Common Monetary Area. The paper used panel annual data for the period 1990 to 2021. The econometric techniques applied herein include the cointegration methods such as the Dynamic Ordinary Least Squares (DOLS) as well as the Fully Modified OLS (FMOLS) to estimate the equilibrium real exchange rate necessary for the computation of the real exchange rate misalignment. These tests were selected owing to their superiority in dealing with serial correlation and endogeneity of variables. The results herein showed that the rear effective exchanged rate among these CMA members (i.e., Eswatini, Lesotho, and Namibia) was misaligned during the review period. In this regard, the paper found evidence of an overvaluation of the real exchange rate by about 2 percent. Literature suggests that an overvaluation is good for import dependent economies.The study further assessed the impact of real exchange rate misalignment on the economies herein. Specifically, the paper used the Bayesian Vector Autoregressive (BVAR) model to examine the long run relationship between the real exchange rate misalignment and key economic variables such as GDP and exports. The results of the impulse response function, within the BVAR framework, show that, a one standard deviation shock or innovation to real effective exchange rate misalignment initially has no material role in explaining variations in GDP fluctuations. This suggests that the GDP of these countries is by and large driven by other factors other than the exchange rate misalignment, and also given that the effects are not direct. Conversely, a one standard deviation shock or innovation to real effective exchange rate misalignment, results in an instant and relatively higher impact to exports of nearly 1 percent, which suggests that misalignment plays a role in the competitiveness of exports in the long run. The outcomes and conclusion of the variance decomposition, to a large extent, resonate with those of the impulse response. Reviewed literature maintains that exchange rate misalignment can be a source of economic instability and can distort investment decisions. Therefore, understanding the sources, magnitude and effects of exchange rate misalignment bears fundamental implications for policy makers in the macroeconomic management and determination of the appropriate exchange rate regime. In this context, this study is invaluable.

Keywords: Real exchange rate; Misalignment; Monetary policy; Common Monetary Area; Trade/Economic Growth; overvaluation (search for similar items in EconPapers)
JEL-codes: F31 (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:aic:revebs:y:2024:j:33:mabakengm

DOI: 10.47743/rebs-2024-1-0005

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